Interesting stuff, but what does one do with it?
The in a “Briefing” under the title “Marginal revolutionaries: The crisis and the blogosphere have opened mainstream economics up to new attack,” the ECONOMIST (12/31/2010) magazine commented on the “heterodox” nature of economic blogs. In typical media fashion it restricts its briefing to macroeconomic, specifically policy-related, issues. That isn’t a criticism. The “Briefing’s” focus is consistent with the magazine’s focus and the reason people (including The Hedged Economist) read the magazine.
However, it really only scratches the surface. As readers of this blog may have sensed, economics can and should inform individuals’ microeconomic decisions. The blog is written in the belief that for most individuals the benefits of applying economics to personal financial decisions will have far great impact on the reader’s well-being than government policies. It isn’t as interesting as policy debates, and thus would be totally inappropriate if The Hedged Economist aspired to mass circulation.
Yet, often policy discussions that incorporate forward looking statements and/or impact analyses are so analytically flawed or preposterous that a posting highlighting them is the proverbial “low hanging fruit.” It’s an easy way for a blogger to provide useful information even if it’s only marginally useful.
To illustrate, this blog originated from a discussion of banking reform. Anyone who acted on the belief that bank reform would eliminate systemic risk undoubtedly found the last few years (especially 2011) difficult. The justifications for skepticism in the initial postings during the first few months of 2010 certainly provided individuals with a better foundation for their thinking. Similarly, heaven help the individual who acted aggressively based on analyses of the fiscal stimulus without realizing how tenuous the assumptions in the analysis were.
There is no doubt debunking policy analysis is low hanging fruit. Even the best policy analysis is almost always peppered with underlying assumptions that when made explicit are absurd. Their absurdity has implications for individual investors. Pointing out the silly assumptions, however, doesn’t make the implications for personal budgeting (and therefore consumption) and investment decisions obvious. It can often necessitate delving into the theoretical underpinning and mathematical expression of the theory.
However, the ECONOMIST tries to discuss the difference in a number of theories about how policy works without addressing some fundamental methodological issues. The reader is free to consult the article to form a judgment about the value of that approach.
One thing is clear from the ECONOMIST’s coverage: in order to take the approach it uses, the author had to totally ignore many methodological issues. Two are particularly important issues from an individual investor’s perspective. Again, that isn’t a criticism; the ECONOMIST’s briefing is interesting. There is no reason the ECONOMIST should have to focus on issues that interest The Hedged Economist.
The first issue the article largely ignores is path dependence. It discusses the different theories largely in terms of end states or stable trajectories. It relies on each theory’s description of how the end state is achieved without any discussion of the impact on the end state of deviations from the hypothesized path. A reasonably imaginative person can envision deviations from each theory’s description of how the economy adjusts that would result in a disastrous end state even if the theory is right.
If you think path doesn’t matter, consider the personal investment implication of this statement of fact. The Dow Jones Industrial average finished the year up about 5% plus dividends. Now ask yourself: Would the economic and stock market outlook for 2012 be the same if that result had been achieved as a smooth path from start to finish?
From a personal finance perspective, deviation from a smooth adjustment could have a substantial impact of how much is available to invest in 2012. To illustrate, some people preferred to sit out the market rather than endure the volatility (a perfectly legitimate responds). The result is they don’t have the market gain to invest in 2012.
Another example concerns options. There are option strategies that make sense for even the most conservative investors. (They’ll be discussed in more detail in a subsequent posting). Volatility in markets makes them more profitable than just buying or selling stocks. More adventurous investors could enhance the profitability of options by using the market’s path dependence. It required also remembering a point made in the first posting on the Fed’s quantitative easing, “Speak Softly But Carry a Big Stick, Dr. Bernanke.” That posting noted that “While the jury is still out, one can at least make a coherent defense of the proposition that liquidity-driven asset price cycles should create covariances that converge over an extraordinarily large set of asset classes and national borders.” In a liquidity-dominated cycle, the volatility can be used to buy target stocks at a discount and sell only at a premium.
Never mind which theory is “right.” Leave that to the ECONOMIST to discuss. Methodologically they all share the same shortcoming. The current state of the economy is not just dependent on current conditions. It also depends upon how those conditions came about. That dependence includes how it will respond to various policies. Often an individual can enhance return by adjusting to how the economy and markets will get where they’re going without risking a big bet on one’s judgment on where it is they’re going.
The second issue the ECONOMIST’s Briefing overlooks is that all of the theories could be right some times and wrong other times while there are other times when none of them apply. Each of the theories is very good at explaining certain observable historical facts; thus right some of the time. But, none of the theories explain all of the observable historical facts; thus wrong some of the time. For the individual the implication is clear. Basically an individual should be very cautious about using the forward-looking implication of any of the theories the ECONOMIST discusses. By contrast, rigorously applying them to understand how the economy got where it is can be productive.
Economists like to think of themselves as scientists. Consequently, the “both right and wrong” is uncomfortable. It seems that they find it (i.e., both wrong and right) harder to admit than to continue arguing. That general aspiration to scientific stature is compounded by the positive returns (both psychic returns of not having to question one’s own beliefs and financial return of aligning with an ideological sponsor). Thus, economists focus on finding an excuse for instances when a theory isn’t supported by events rather than define the boundaries over which the theory can be useful. Excuses are a lot more comfortable than trying to figure out ahead of time what model is appropriate at any given point.
However, even physical sciences have to deal with uncertainty. At the most micro level, the physical sciences have taken to discussing waves of probability. That’s true even though physical scientists deal with phenomena that we assume are stable across space and time. Economists have to deal with phenomena that may not rigorously conform to that model.
Neuroeconomics and behavioral economics (two specialties in economics) have added information that has implications for even the most macro policy analysis. Yet, to date much of the focus of neuro and behavioral economics has been on individuals’ market behaviors, and even there the research tends to hint at implications rather than subject them to extensive testing at the market level. One thing is very clear: in economics, stability over time is limited, and if space is equivalent to context, stability across space doesn’t exist.
Both specialties provide ample evidence supporting this blog’s frequent references to the fallacy of assuming consistent (i.e., linear) responses to policies. To illustrate using an obvious example, both specialties (as well as stock market lore) provide evidence that potential gain and potential loss are not handled the same. Behavioral economics indicates reactions and behavior are different depending on whether the current situation is perceived as resulting from previous gain or previous loss. The market lore is that loss avoidance trades (whether selling or short covering) are more abrupt than the pursuit of gains. Neuroeconomics indicates fear of loss isn’t even processed in the same part of the brain as expectations of gains.
Interestingly, some econometricians have tried to address this asymmetry by estimating the relationships separately for upward and downward changes. That’s just one example. It’s getting to be very clear that macroeconomists are going to have to tighten their definitions of when their theories (i.e., models) apply. In other words, they need to be far more diligent about defining ALL the assumptions they are making. Most importantly, they need to acknowledge the evidence they ignore. One can’t know the future, but one can measure the present including what people are presently saying about the future. Often looking very closely at assumptions can assist an investor in judging how to interpret that information.
For the individual, the broader implication is quite simple: be very careful about assuming that what has worked in the past is going to work in the future. Any investment approach should be back-tested. However, investors should be careful how they use the results. Investing is about the future.
There is a very delightful book entitled THE HERETICS OF FINANCE by Andrew W. Lo and Jasmina Hasanhodzic. (Andrew Lo’s name may seem familiar to followers of this blog. His book entitled A NON-RANDOM WALK DOWN WALL STREET is one source this blog cited for econometric data illustrating the limitation of financial economics). The subtitle of HERETICS is “Conversations with Leading Practitioners of Technical Analysis.” It’s “delightful” because it provides examples of different approaches that most practitioners characterize as working until they stop working. That’s a useful insight when considering the value of back-casts.
In summary, the ECONOMIST’s briefing ignores two points individual investors should never ignore: first, adjustment paths can determine end states, and second, economists can add information. Economics can inform an investor about the present, but it can’t do much to reduce the uncertainty of the future. That’s the individual investor’s responsibility.
Monday, January 30, 2012
Sunday, January 15, 2012
The Role of Banks
“Cut out the middleman.” Facebook is more threatening than the “occupy” crowd.
Since the seasonal reference to “It’s a Wonderful Life” was late this year, perhaps a second reference is appropriate penitence. The last posting, “If the Plan is Right, Stick to It,” addressed personal financial management. It made the simple point that a financial plan that involves running around like a chicken with its head cut off isn’t the way to a wonderful life. Now it’s time to see what “It’s a Wonderful Life” says about banks.
First thing to note is that the Bailey’s are bankers throughout the movie (technically Bailey Building and Loan is an S&L, a distinction made obsolete years ago). Potter, by contrast, becomes a banker when he “takes-over” a bank during a run. The efforts of hedged funds and private equity funds to buy into banking during the recent crisis are similar to Potter’s “takeover.”
The parallels are interesting, but that was the 1930’s and 2008-2009, this is now. Does the movie say anything relevant to today? It says a lot that is timely. Look closely and the movie says a lot about what banks are and how much power they can have.
The first point is easy to miss. In the picture labeled Scene 1 Potter is describing George’s success at avoiding Potter’s control. It’s a meeting between two bankers. What is easy to miss is that Potter refused a telephone call in order to meet with George. Listen closely: he tells his secretary to “tell the congressman he’ll have to call back.” Potter, who craves power, has political contacts. George, by contrast, runs his bank without such contacts.
Scene 1
It’s telling that a bank isn’t enough for the one seeking power. He needs political contacts. Perhaps banks don’t have that much power. They may just be instruments the government uses. Regulation is simply the government trying to preserve its tool.
The situation represented in Scene 2 contains an obvious fact about banks that the media and political demagogues love to overlook. George is explaining banking to his customers. He is explaining that the bank doesn’t have piles of money “back in the vault.” It has assets. To paraphrase the terms in which George explains banking to a customer, “your money is in your neighbor’s house.”
Scene 2
It’s silly when the media and politicians (and embarrassingly, some economists) say banks are sitting on the money rather than lending it. How stupid can they be? The bank’s business is lending. Banks sit on money only to the extent they are required to in order to meet regulatory reserve requirements.
If you think banks aren’t lending as freely as they should (a belief not shared by The Hedged Economist), you should consider this quote from the March 3, 2010 posting “Regulatory capital and who’s got the money?”
“What we know about reserves is that people lower them in good times and raise them in bad times. We also know this aggravates the cycle. Well, surprise, surprise, governments are people; they do the same thing. Unfortunately, the government has a long history of changing capital requirements in the wrong direction over the business cycle.”
Similarly, if you believe banks lend to the wrong people, look closely at the risk factors assigned to various types of loans (the risk factors determine how big the reserves banks have to hold will be). It shouldn’t be a surprise that a bank that lends to the government doesn’t have to hold as much in reserves as one that actually lends to people.
The picture in Scene 3 was used in “If the Plan is Right, Stick to It” to illustrate a point about George’s situation. But, it has broader implications because it is easy to misinterpret. In fact, George is guilty of the misinterpretation.
Scene 3
While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. Turns out, George is wrong.
Scene 4 and Scene 5 illustrate the truth about liquidity.
Scene 4
Scene 5
Scenes 4 and 5 make it quite clear that Potter, and, for that matter, George aren’t the source of liquidity. George’s comment regarding Potter should sound familiar to those who think banks have money. Yet, the happy ending to the story results from the fact that it’s people who create liquidity and all capital by not consuming everything they earn.
The image of villainous bankers deserves no more attention than the villainous merchant. Intermediaries are hardly powerful or the source of the merchandise they sell. That’s true whether the merchandise is a piece of apparel or a loan. Middlemen whether merchants or bankers have to justify themselves regularly.
The most obvious way to eliminate an intermediary is to just stop using their service. That is happening with banks to the extent that people stop borrowing. It’s even more dramatic when they pay off debts. This, of course, increases the overall savings rate when done with current income. However, if existing savings are used instead of debt or debt is paid off from existing savings, the use of banks can be reduced without much of an impact on the portion of current income the person has to save.
George’s experience raises an interesting issue. Potter, the impersonal investor, evaluates George as a borrower based on collateral. By contrast, the populace evaluates him as an individual. For most of history, the ability to evaluate an individual was the way banks justified their role as intermediaries. (Manual underwriting is the term often used to describe the process). It was a high cost way to allocate capital.
Much is made of the competition between community banks that can “know their customers” and large impersonal banks. The discussion overlooks the broader issue. Just as the populace didn’t need a bank to act as intermediary between them and George, there is always a risk of “eliminating the middleman” if the intermediary can’t justify itself. That is a risk faced by banks large and small.
Large banks depend on scale built around their access to large amount of capital at advantageous rates. In the corporate sector that justification was undermined by the corporate commercial paper market. The large banks have used the systems for consumer credit evaluation to gain the scale they need in consumer markets.
Credit scores, automated underwriting systems, risk models, and numerous other systems were designed to reduce the cost. Many of those systems failed during the financial crisis, but even if improved and refined, the systems represent a shift toward Potter’s model. They facilitate scale, but do it by undermining the traditional justification for the banks’ role as intermediary.
Interestingly, the Potter approach requires a legal system where there is clear title and contract law. In THE MYSTERY OF CAPITAL Hernado de Soto points out how these factors, so necessary for the Potter approach to work, are missing in many parts of the world. In those places, a system closer to the George’s model may develop. However, its cost would always be a limit on the availability of credit to a large segment of the population.
The real threat to banks is technology, not the investment risks the banks take. Using technology, and integrating with Facebook, Lenddo.com has developed a community approach based on George’s reliance on character while offering the potential for scale. Their website describes the approach as “By combining community-based micro-lending techniques with social media endorsements, Lenddo is the first credit scoring platform optimized for emerging markets; specifically, markets where traditional credit scores and collateral frameworks may not exist.”
Lending was once based on character and relationship. Social networks have the potential to restore the sound lending practices of the past. And it looks like it already is starting to happen.
Facebook’s COO Sheryl Sandberg said this weekend in the WSJ interview “We would like everyone who builds products to use Facebook. Our vision is that industries get disrupted and [they get] rebuilt with people at the center. The gaming industry has been really impacted by these social gaming companies like Zynga and Playdom. By putting people at the center, they took a totally different approach to games. We think this will happen to every industry.”
Or, as Facebook CEO Mark Zuckerberg said in 2010, “If you look five years out, every industry is going to be rethought in a social way.”
Social lending has caught on with the Lenddo community in places like the Philippines, but if Mark is right a social approach has the potential for radical improvement over the way US and Western European banks traditionally do consumer banking, which has global implications. Thus, it shouldn’t be surprising then that The Hedged Economist is long Lenddo.com.
Since the seasonal reference to “It’s a Wonderful Life” was late this year, perhaps a second reference is appropriate penitence. The last posting, “If the Plan is Right, Stick to It,” addressed personal financial management. It made the simple point that a financial plan that involves running around like a chicken with its head cut off isn’t the way to a wonderful life. Now it’s time to see what “It’s a Wonderful Life” says about banks.
First thing to note is that the Bailey’s are bankers throughout the movie (technically Bailey Building and Loan is an S&L, a distinction made obsolete years ago). Potter, by contrast, becomes a banker when he “takes-over” a bank during a run. The efforts of hedged funds and private equity funds to buy into banking during the recent crisis are similar to Potter’s “takeover.”
The parallels are interesting, but that was the 1930’s and 2008-2009, this is now. Does the movie say anything relevant to today? It says a lot that is timely. Look closely and the movie says a lot about what banks are and how much power they can have.
The first point is easy to miss. In the picture labeled Scene 1 Potter is describing George’s success at avoiding Potter’s control. It’s a meeting between two bankers. What is easy to miss is that Potter refused a telephone call in order to meet with George. Listen closely: he tells his secretary to “tell the congressman he’ll have to call back.” Potter, who craves power, has political contacts. George, by contrast, runs his bank without such contacts.
Scene 1
It’s telling that a bank isn’t enough for the one seeking power. He needs political contacts. Perhaps banks don’t have that much power. They may just be instruments the government uses. Regulation is simply the government trying to preserve its tool.
The situation represented in Scene 2 contains an obvious fact about banks that the media and political demagogues love to overlook. George is explaining banking to his customers. He is explaining that the bank doesn’t have piles of money “back in the vault.” It has assets. To paraphrase the terms in which George explains banking to a customer, “your money is in your neighbor’s house.”
Scene 2
It’s silly when the media and politicians (and embarrassingly, some economists) say banks are sitting on the money rather than lending it. How stupid can they be? The bank’s business is lending. Banks sit on money only to the extent they are required to in order to meet regulatory reserve requirements.
If you think banks aren’t lending as freely as they should (a belief not shared by The Hedged Economist), you should consider this quote from the March 3, 2010 posting “Regulatory capital and who’s got the money?”
“What we know about reserves is that people lower them in good times and raise them in bad times. We also know this aggravates the cycle. Well, surprise, surprise, governments are people; they do the same thing. Unfortunately, the government has a long history of changing capital requirements in the wrong direction over the business cycle.”
Similarly, if you believe banks lend to the wrong people, look closely at the risk factors assigned to various types of loans (the risk factors determine how big the reserves banks have to hold will be). It shouldn’t be a surprise that a bank that lends to the government doesn’t have to hold as much in reserves as one that actually lends to people.
The picture in Scene 3 was used in “If the Plan is Right, Stick to It” to illustrate a point about George’s situation. But, it has broader implications because it is easy to misinterpret. In fact, George is guilty of the misinterpretation.
Scene 3
While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. Turns out, George is wrong.
Scene 4 and Scene 5 illustrate the truth about liquidity.
Scene 4
Scene 5
Scenes 4 and 5 make it quite clear that Potter, and, for that matter, George aren’t the source of liquidity. George’s comment regarding Potter should sound familiar to those who think banks have money. Yet, the happy ending to the story results from the fact that it’s people who create liquidity and all capital by not consuming everything they earn.
The image of villainous bankers deserves no more attention than the villainous merchant. Intermediaries are hardly powerful or the source of the merchandise they sell. That’s true whether the merchandise is a piece of apparel or a loan. Middlemen whether merchants or bankers have to justify themselves regularly.
The most obvious way to eliminate an intermediary is to just stop using their service. That is happening with banks to the extent that people stop borrowing. It’s even more dramatic when they pay off debts. This, of course, increases the overall savings rate when done with current income. However, if existing savings are used instead of debt or debt is paid off from existing savings, the use of banks can be reduced without much of an impact on the portion of current income the person has to save.
George’s experience raises an interesting issue. Potter, the impersonal investor, evaluates George as a borrower based on collateral. By contrast, the populace evaluates him as an individual. For most of history, the ability to evaluate an individual was the way banks justified their role as intermediaries. (Manual underwriting is the term often used to describe the process). It was a high cost way to allocate capital.
Much is made of the competition between community banks that can “know their customers” and large impersonal banks. The discussion overlooks the broader issue. Just as the populace didn’t need a bank to act as intermediary between them and George, there is always a risk of “eliminating the middleman” if the intermediary can’t justify itself. That is a risk faced by banks large and small.
Large banks depend on scale built around their access to large amount of capital at advantageous rates. In the corporate sector that justification was undermined by the corporate commercial paper market. The large banks have used the systems for consumer credit evaluation to gain the scale they need in consumer markets.
Credit scores, automated underwriting systems, risk models, and numerous other systems were designed to reduce the cost. Many of those systems failed during the financial crisis, but even if improved and refined, the systems represent a shift toward Potter’s model. They facilitate scale, but do it by undermining the traditional justification for the banks’ role as intermediary.
Interestingly, the Potter approach requires a legal system where there is clear title and contract law. In THE MYSTERY OF CAPITAL Hernado de Soto points out how these factors, so necessary for the Potter approach to work, are missing in many parts of the world. In those places, a system closer to the George’s model may develop. However, its cost would always be a limit on the availability of credit to a large segment of the population.
The real threat to banks is technology, not the investment risks the banks take. Using technology, and integrating with Facebook, Lenddo.com has developed a community approach based on George’s reliance on character while offering the potential for scale. Their website describes the approach as “By combining community-based micro-lending techniques with social media endorsements, Lenddo is the first credit scoring platform optimized for emerging markets; specifically, markets where traditional credit scores and collateral frameworks may not exist.”
Lending was once based on character and relationship. Social networks have the potential to restore the sound lending practices of the past. And it looks like it already is starting to happen.
Facebook’s COO Sheryl Sandberg said this weekend in the WSJ interview “We would like everyone who builds products to use Facebook. Our vision is that industries get disrupted and [they get] rebuilt with people at the center. The gaming industry has been really impacted by these social gaming companies like Zynga and Playdom. By putting people at the center, they took a totally different approach to games. We think this will happen to every industry.”
Or, as Facebook CEO Mark Zuckerberg said in 2010, “If you look five years out, every industry is going to be rethought in a social way.”
Social lending has caught on with the Lenddo community in places like the Philippines, but if Mark is right a social approach has the potential for radical improvement over the way US and Western European banks traditionally do consumer banking, which has global implications. Thus, it shouldn’t be surprising then that The Hedged Economist is long Lenddo.com.
Wednesday, January 11, 2012
If the Plan Is Right, Stick to It
Adjust, but don’t abandon a plan that isn’t broke.
It’s a little late: the annual reference to “It’s a Wonderful Life” is overdue. The first such reference in “Did the repeal of Glass Steagall create big banks and lead to the financial crisis?” was in reference to policy. The next year in “Investing Part 3: Setting the volume” the focus shifted toward personal finance and addressed a more subtle issue than the Henry Potter verses George Bailey confrontation.
This year’s first reference sticks with the focus on an individual’s financial management. The point is simple. If one has a good plan, stck to it.
Aficionados of the movie may recognize the scenes. Just as the run on the Bailey Building and Loan referenced in “Investing Part 3: Setting the volume” contained some subtle points, so too do these scenes.
Scene 1
In Scene 1 Potter is summarizing George Bailey’s current situation in preparation for offering him a job. Listen close and you’ll note that George at age 27 is setting aside (i.e., saving) over 20% of his earnings while paying his mortgage. While the dollar figures are quaint after the intervening seventy some years of inflation, it’s telling.
Potter doesn’t get it. He belittles George’s situation, yet acknowledges the George has “beaten” him and cites the bank run as an example. Potter’s explanation is that George kept his head during the panic.
It just doesn’t occur to Potter that keeping one’s head is a lot easier if one has been regularly saving. That’s a timeless truth. If one has a plan, external events like a panic aren’t what drives one’s actions. George’s plans change throughout the movie, but he changes them because his objectives change (e.g., save his father’s legacy in the building and loan, let his brother pursue “research,” marry Mary, save the building and loan from a bank run, etc.). Yet, those changes are a response to events, not a change in plans due to the latest news.
Fast forward to 2012. People who were saving 20% of their income were less likely to see 2011 as a year in which volatility forced them to adjust their portfolio in response to every shift from “risk on” to “risk off.” Similarly, they probably didn’t experience 2008 and 2009 as a reason to panic. While the dollar volatility of savers’ portfolios may have been bigger, their plans could stay the same. In fact, like Potter and George, they may have seen the recent events as a time to invest. Volatility certainly creates opportunities for the investor, but that’s a topic for another posting. It doesn’t require a new plan to capitalize on volatility.
Scene 2
In Scene 2 George is pleading for a loan from Potter. Many business owners invest everything they have in their business. We learn that George put everything into the Bailey Building and Loan. When Uncle Billy loses a deposit, George has no liquid assets. Concentration and focus are necessary in a business, but as an investment strategy, they create risks one ought to avoid.
Potter, who knows George’s situation, asks what assets George has that can be used as collateral for the loan. George isn’t broke. He mentions a life insurance policy. (It has some cash value. So, it’s what is known as whole life.) The cash value (surrender value) is well short of the amount George needs. Remember he has also been paying a mortgage. He has undoubtedly built equity through payments. It’s also worth remembering his home was bought during the depression and Scene 2 takes place post World War II, so inflation has added to his equity. His problem is the shortfall at the Building and Loan. George has assets, but not the liquidity of cash.
It’s interesting that treating home equity as a liquid asset is never even raised as an issue. Does that represent a difference in financial markets or a difference in how people planned? George put every penny into his business, but he didn’t “bet the ranch” (i.e., use a mortgage to raise capital), quite different from using an equity line to finance consumption. Having a home isn’t a part of George’s plan that he is willing to risk.
While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. When Potter turns George down, George makes his big mistake.
Scene 3
In Scene 3, having been turned down by Potter, George contemplates letting events determine his action. It takes Clarence Oddbody, Angel Second Class, to show George the folly of letting events determine one’s plan. In the end, George realizes how foolish it would be to let events determine his life. That realization sends George on the path to the movie’s happy ending.
It’s a little late: the annual reference to “It’s a Wonderful Life” is overdue. The first such reference in “Did the repeal of Glass Steagall create big banks and lead to the financial crisis?” was in reference to policy. The next year in “Investing Part 3: Setting the volume” the focus shifted toward personal finance and addressed a more subtle issue than the Henry Potter verses George Bailey confrontation.
This year’s first reference sticks with the focus on an individual’s financial management. The point is simple. If one has a good plan, stck to it.
Aficionados of the movie may recognize the scenes. Just as the run on the Bailey Building and Loan referenced in “Investing Part 3: Setting the volume” contained some subtle points, so too do these scenes.
Scene 1
In Scene 1 Potter is summarizing George Bailey’s current situation in preparation for offering him a job. Listen close and you’ll note that George at age 27 is setting aside (i.e., saving) over 20% of his earnings while paying his mortgage. While the dollar figures are quaint after the intervening seventy some years of inflation, it’s telling.
Potter doesn’t get it. He belittles George’s situation, yet acknowledges the George has “beaten” him and cites the bank run as an example. Potter’s explanation is that George kept his head during the panic.
It just doesn’t occur to Potter that keeping one’s head is a lot easier if one has been regularly saving. That’s a timeless truth. If one has a plan, external events like a panic aren’t what drives one’s actions. George’s plans change throughout the movie, but he changes them because his objectives change (e.g., save his father’s legacy in the building and loan, let his brother pursue “research,” marry Mary, save the building and loan from a bank run, etc.). Yet, those changes are a response to events, not a change in plans due to the latest news.
Fast forward to 2012. People who were saving 20% of their income were less likely to see 2011 as a year in which volatility forced them to adjust their portfolio in response to every shift from “risk on” to “risk off.” Similarly, they probably didn’t experience 2008 and 2009 as a reason to panic. While the dollar volatility of savers’ portfolios may have been bigger, their plans could stay the same. In fact, like Potter and George, they may have seen the recent events as a time to invest. Volatility certainly creates opportunities for the investor, but that’s a topic for another posting. It doesn’t require a new plan to capitalize on volatility.
Scene 2
In Scene 2 George is pleading for a loan from Potter. Many business owners invest everything they have in their business. We learn that George put everything into the Bailey Building and Loan. When Uncle Billy loses a deposit, George has no liquid assets. Concentration and focus are necessary in a business, but as an investment strategy, they create risks one ought to avoid.
Potter, who knows George’s situation, asks what assets George has that can be used as collateral for the loan. George isn’t broke. He mentions a life insurance policy. (It has some cash value. So, it’s what is known as whole life.) The cash value (surrender value) is well short of the amount George needs. Remember he has also been paying a mortgage. He has undoubtedly built equity through payments. It’s also worth remembering his home was bought during the depression and Scene 2 takes place post World War II, so inflation has added to his equity. His problem is the shortfall at the Building and Loan. George has assets, but not the liquidity of cash.
It’s interesting that treating home equity as a liquid asset is never even raised as an issue. Does that represent a difference in financial markets or a difference in how people planned? George put every penny into his business, but he didn’t “bet the ranch” (i.e., use a mortgage to raise capital), quite different from using an equity line to finance consumption. Having a home isn’t a part of George’s plan that he is willing to risk.
While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. When Potter turns George down, George makes his big mistake.
Scene 3
In Scene 3, having been turned down by Potter, George contemplates letting events determine his action. It takes Clarence Oddbody, Angel Second Class, to show George the folly of letting events determine one’s plan. In the end, George realizes how foolish it would be to let events determine his life. That realization sends George on the path to the movie’s happy ending.
Thursday, December 29, 2011
Note to Bloomberg: Sometimes it’s Quite Simple.
Speak up now or focus on other issues where you’re more knowledgeable.
“Bloomberg Can Do Better” and “If Bloomberg Had Done it Right, They Could Have Been Heroes” discussed Bloomberg’s retrospective analysis of Fed policy during the financial crisis. As the titles of the postings imply, their analysis came up short. This blog has often been critical of Fed policy, but Bloomberg is wrong to criticize Fed policy during the liquidity crisis.
During a liquidity crisis success is easy to identify, especially after the fact. BARON’S put it fairly succinctly in “Bankers' Boon: Opening the Spigots Redux.” The relevant quote is: “Turn to the writings of Walter Bagehot, the 19th-century editor who wrote an early treatise on modern lender-of-last-resort theory—the basis for central banking. Bagehot differentiated liquidity-lending by making recipients pay up for the money, guaranteeing swift payback.”
The BARON’S article focuses on current policy. It is as critical of current Fed policy as this blog’s recent posting culminating in “Stimulus Can Backfire: Monetary Policy.” BARON’S focuses on the ultimate reason the current Fed policy is ill-advised: The Fed has tools that can remedy liquidity problems. When the problem doesn’t originate from liquidity, monetary policy can find itself “pushing on a straw.”
In Europe, the liquidity issues are the symptom not the cause. Monetary policy can accommodate a response, but the Fed isn’t the European Central Bank (ECB). Interestingly, the ECB recognizes that monetary policy should be a second tier player. Why can’t the Fed?
“Bloomberg Can Do Better” and “If Bloomberg Had Done it Right, They Could Have Been Heroes” discussed Bloomberg’s retrospective analysis of Fed policy during the financial crisis. As the titles of the postings imply, their analysis came up short. This blog has often been critical of Fed policy, but Bloomberg is wrong to criticize Fed policy during the liquidity crisis.
During a liquidity crisis success is easy to identify, especially after the fact. BARON’S put it fairly succinctly in “Bankers' Boon: Opening the Spigots Redux.” The relevant quote is: “Turn to the writings of Walter Bagehot, the 19th-century editor who wrote an early treatise on modern lender-of-last-resort theory—the basis for central banking. Bagehot differentiated liquidity-lending by making recipients pay up for the money, guaranteeing swift payback.”
The BARON’S article focuses on current policy. It is as critical of current Fed policy as this blog’s recent posting culminating in “Stimulus Can Backfire: Monetary Policy.” BARON’S focuses on the ultimate reason the current Fed policy is ill-advised: The Fed has tools that can remedy liquidity problems. When the problem doesn’t originate from liquidity, monetary policy can find itself “pushing on a straw.”
In Europe, the liquidity issues are the symptom not the cause. Monetary policy can accommodate a response, but the Fed isn’t the European Central Bank (ECB). Interestingly, the ECB recognizes that monetary policy should be a second tier player. Why can’t the Fed?
Saturday, December 17, 2011
Now We Know Who the Rich Are
Forget the 1%. Anyone who expects to retire is guilty
The posting entitled “It’s Easier to Fan Envy than Formulate Policies That Work” noted the tendency for envy to run amuck. It pointed out: “Once taking things in order to give them to the ‘little guy’ is set loose, there’s no telling who will become the ‘big guy’.” That posting used an article targeting teachers as those who should take a hit, but it referenced a previous posting citing a raft of articles identifying various candidates for “big guy” and “little guy” status. It’s such an absurd way for people to divert attention from the failure of their policies.
If one needs confirmation of how unproductive it is and how drastic the policy failure has been, consider this. Liberal commentators criticize of the Bush tax cuts for allowing the rich to keep too much of the income GAINS. Contrast that to now when the issue is who will take the CUTs: taxpayers or government, upper income or users of exemptions (a.k.a., loopholes), “entitlements” or discretionary spending, etc. The total absence of a growth policy is evident.
As some politicians push ahead with the political posturing, pretending that it is the distribution that matters, we clearly should expect them to look for more inclusive definitions of the rich. It’s an inevitable outcome of the failure to develop policies that grow the economy. As pointed out in other postings, absent an inclusive definition of who to target as the rich, the math doesn’t work.
Trying to define the rich is getting increasingly absurd. It’s simple. One can tell whether one feels rich, but that’s more a state of mind than income level or net worth. Most people feel rich when they have what they need and feel secure about being able to continue to have what they need. In “Enough Money for Retirement? Even the Rich Say No,” CNBC illustrates the disasters that spring from trying to judge “rich” for others.
The article quotes the finding that: "Even among those considered 'well off,' many seem to fear a sharp drop in their post-retirement standard of living due to insufficient retirement savings.” The author may not realize the implication. The article is arguing that those considered rich aren’t rich. It shows that whomever is doing the “considering” is wrong. If nothing else, the article makes it clear the author has proven that he or she can’t identify the rich.
But, undeterred by the self-contradiction, instead of pointing out the futility of trying to judge whether other people are rich, the piece forges ahead. That’s when the absurdity really surfaces.
“Other findings of the survey:
• About a quarter of affluent Americans say they are not confident they will have saved enough for retirement, and this is especially true for Americans with assets between $100,000 and $250,000 (33 percent) and women (31 percent).”
Who are the rich in the article? It states: “In the survey, Americans had to have investable assets of $100,000, excluding real estate and other property, to be considered affluent.” Talk about absurd. No reference to employer benefits, ignoring age, no reference to work history and the resulting social security income, and a threshold so low that it includes most people who have planned for retirement (especially those closer to retirement). Certainly, anyone planning to retire and dependent on a 401(k) for retirement should be among their definition of rich. If the value of benefits at retirement is included as investable assets, almost anyone with a defined benefits pension is among the rich. Almost any employer health insurance coverage during retirement would put the person among the rich.
The conclusion one has to reach is that we’ve finally found a definition of rich that is broad enough to make the redistribution math work; include anyone with a pension, anyone with retirement health coverage, and anyone who has planned for retirement.
The posting entitled “It’s Easier to Fan Envy than Formulate Policies That Work” noted the tendency for envy to run amuck. It pointed out: “Once taking things in order to give them to the ‘little guy’ is set loose, there’s no telling who will become the ‘big guy’.” That posting used an article targeting teachers as those who should take a hit, but it referenced a previous posting citing a raft of articles identifying various candidates for “big guy” and “little guy” status. It’s such an absurd way for people to divert attention from the failure of their policies.
If one needs confirmation of how unproductive it is and how drastic the policy failure has been, consider this. Liberal commentators criticize of the Bush tax cuts for allowing the rich to keep too much of the income GAINS. Contrast that to now when the issue is who will take the CUTs: taxpayers or government, upper income or users of exemptions (a.k.a., loopholes), “entitlements” or discretionary spending, etc. The total absence of a growth policy is evident.
As some politicians push ahead with the political posturing, pretending that it is the distribution that matters, we clearly should expect them to look for more inclusive definitions of the rich. It’s an inevitable outcome of the failure to develop policies that grow the economy. As pointed out in other postings, absent an inclusive definition of who to target as the rich, the math doesn’t work.
Trying to define the rich is getting increasingly absurd. It’s simple. One can tell whether one feels rich, but that’s more a state of mind than income level or net worth. Most people feel rich when they have what they need and feel secure about being able to continue to have what they need. In “Enough Money for Retirement? Even the Rich Say No,” CNBC illustrates the disasters that spring from trying to judge “rich” for others.
The article quotes the finding that: "Even among those considered 'well off,' many seem to fear a sharp drop in their post-retirement standard of living due to insufficient retirement savings.” The author may not realize the implication. The article is arguing that those considered rich aren’t rich. It shows that whomever is doing the “considering” is wrong. If nothing else, the article makes it clear the author has proven that he or she can’t identify the rich.
But, undeterred by the self-contradiction, instead of pointing out the futility of trying to judge whether other people are rich, the piece forges ahead. That’s when the absurdity really surfaces.
“Other findings of the survey:
• About a quarter of affluent Americans say they are not confident they will have saved enough for retirement, and this is especially true for Americans with assets between $100,000 and $250,000 (33 percent) and women (31 percent).”
Who are the rich in the article? It states: “In the survey, Americans had to have investable assets of $100,000, excluding real estate and other property, to be considered affluent.” Talk about absurd. No reference to employer benefits, ignoring age, no reference to work history and the resulting social security income, and a threshold so low that it includes most people who have planned for retirement (especially those closer to retirement). Certainly, anyone planning to retire and dependent on a 401(k) for retirement should be among their definition of rich. If the value of benefits at retirement is included as investable assets, almost anyone with a defined benefits pension is among the rich. Almost any employer health insurance coverage during retirement would put the person among the rich.
The conclusion one has to reach is that we’ve finally found a definition of rich that is broad enough to make the redistribution math work; include anyone with a pension, anyone with retirement health coverage, and anyone who has planned for retirement.
Saturday, December 10, 2011
It’s Easier to Fan Envy than Formulate Policies That Work
Obama takes the destructive path
The article on wealth by age and similar articles cited in “The 99%ers: Part 7” illustrate why limousine liberals can’t get me to buy into their class warfare rhetoric. They all illustrate the problem. Once taking things in order to give them to the “little guy” is set loose, there’s no telling who will become the “big guy.” Yeh, the older generation is wealthier than youth. So what?
Another article entitled “Public School Teachers Aren't Underpaid” also illustrates the problem. Andrew G. Biggs and Jason Richwine conclude: “Our research suggests that on average—counting salaries, benefits and job security—teachers receive about 52% more than they could in private business.”
While most people, maybe 99%, may be in one of the target groups of the so called 99%ers, Teachers are in the crosshairs in this article. It isn’t surprising that people with pensions look like a privileged class to the majority of Americans who don’t have pensions. Many public employees have seen the same thing regarding public sector employer-paid health insurance. It’s so disappointing to see such jealousy. Yeh, teachers benefited from being in the teacher’s union. So what?
None of the articles are surprising, but it’s disappointing when a political party makes it the central theme of their election efforts. What doesn’t seem to change is politicians’ belief that people are stupid. How else can one explain Obama’s quote: “This is not class warfare. It is math.” He’s talking about a tax of undefined size, applying it to the wealthy that is defined differently depending on the audience, and a tax that is so vague there isn’t a revenue estimate attached. That may not be class warfare, but it sure isn’t math.
Maybe he says that because he doesn’t have anyone around to do the math for him, but it’s more likely he doesn’t do the math because his math doesn’t work. Even more important than the fact that his math doesn’t work is his firm belief that the public is so stupid it can’t figure out that multiple trillions of dollars aren’t going to come from taxing millionaires (even if he fudges the definition of millionaire to include people with a $250k or $200k income). There just aren’t enough millionaires by any of his definitions.
That said, whether one favors smaller differences in incomes or rejoices in the diversity of incomes is a normative decision (i.e., a value judgment) that we are all entitled to make. What is disappointing is that one political party has so little faith in American’s sense of fair play and equity, their intelligence, and their generosity. Rather than appealing to what is noble in human nature, they believe their success requires appealing to baser motives, distortions and lying, demagoguery, and cultivating dependence.
It will be tragic if it works for Obama, because he’ll reap the whirlwind. The math won’t go away. There is darn good reason “thou shalt not covet thy neighbors’ …” is one of the Ten Commandments. I just can’t understand why more people can’t rejoice in other peoples’ good fortune.
The article on wealth by age and similar articles cited in “The 99%ers: Part 7” illustrate why limousine liberals can’t get me to buy into their class warfare rhetoric. They all illustrate the problem. Once taking things in order to give them to the “little guy” is set loose, there’s no telling who will become the “big guy.” Yeh, the older generation is wealthier than youth. So what?
Another article entitled “Public School Teachers Aren't Underpaid” also illustrates the problem. Andrew G. Biggs and Jason Richwine conclude: “Our research suggests that on average—counting salaries, benefits and job security—teachers receive about 52% more than they could in private business.”
While most people, maybe 99%, may be in one of the target groups of the so called 99%ers, Teachers are in the crosshairs in this article. It isn’t surprising that people with pensions look like a privileged class to the majority of Americans who don’t have pensions. Many public employees have seen the same thing regarding public sector employer-paid health insurance. It’s so disappointing to see such jealousy. Yeh, teachers benefited from being in the teacher’s union. So what?
None of the articles are surprising, but it’s disappointing when a political party makes it the central theme of their election efforts. What doesn’t seem to change is politicians’ belief that people are stupid. How else can one explain Obama’s quote: “This is not class warfare. It is math.” He’s talking about a tax of undefined size, applying it to the wealthy that is defined differently depending on the audience, and a tax that is so vague there isn’t a revenue estimate attached. That may not be class warfare, but it sure isn’t math.
Maybe he says that because he doesn’t have anyone around to do the math for him, but it’s more likely he doesn’t do the math because his math doesn’t work. Even more important than the fact that his math doesn’t work is his firm belief that the public is so stupid it can’t figure out that multiple trillions of dollars aren’t going to come from taxing millionaires (even if he fudges the definition of millionaire to include people with a $250k or $200k income). There just aren’t enough millionaires by any of his definitions.
That said, whether one favors smaller differences in incomes or rejoices in the diversity of incomes is a normative decision (i.e., a value judgment) that we are all entitled to make. What is disappointing is that one political party has so little faith in American’s sense of fair play and equity, their intelligence, and their generosity. Rather than appealing to what is noble in human nature, they believe their success requires appealing to baser motives, distortions and lying, demagoguery, and cultivating dependence.
It will be tragic if it works for Obama, because he’ll reap the whirlwind. The math won’t go away. There is darn good reason “thou shalt not covet thy neighbors’ …” is one of the Ten Commandments. I just can’t understand why more people can’t rejoice in other peoples’ good fortune.
Wednesday, December 7, 2011
If Bloomberg Had Done it Right, They Could Have Been Heroes
Bloomberg News Responds to Bernanke Criticism
If the initial coverage had been written with the same professionalism and objectivity as their defense, Bloomberg would not be forced to defend it. The articles, especially “Secret Fed Loans Gave Banks $13 Billion,” read like poorly written editorials rather than serious reporting. For an explanation, see: “Bloomberg Can Do Better”.
On Tom Keen’s midday surveillance today (12/07/11), Bloomberg’s Matthew Winkler defended Bloomberg’s accomplishment in getting the information . As pointed out in the posting cited above, there is no doubt Bloomberg provided a public service by forcing the issue. However, as Mr. Winkler pointed out, there is an important issue that needs to be addressed: When should detailed data on actions taken during a liquidity crisis be disclosed? Bloomberg’s coverage could have contributed to that discussion. Unfortunately, the editorial tone of their coverage probably discouraged serious consideration of timing.
Their defense is factually correct, but misrepresents the lack of objectivity of their coverage. Rather than go through their defense point-by-point (something anticipated fairly well in the initial posting), I only request that they reread their coverage and ask themselves one question: Can Bloomberg do better? I believe so, or I would not be writing this.
If the initial coverage had been written with the same professionalism and objectivity as their defense, Bloomberg would not be forced to defend it. The articles, especially “Secret Fed Loans Gave Banks $13 Billion,” read like poorly written editorials rather than serious reporting. For an explanation, see: “Bloomberg Can Do Better”.
On Tom Keen’s midday surveillance today (12/07/11), Bloomberg’s Matthew Winkler defended Bloomberg’s accomplishment in getting the information . As pointed out in the posting cited above, there is no doubt Bloomberg provided a public service by forcing the issue. However, as Mr. Winkler pointed out, there is an important issue that needs to be addressed: When should detailed data on actions taken during a liquidity crisis be disclosed? Bloomberg’s coverage could have contributed to that discussion. Unfortunately, the editorial tone of their coverage probably discouraged serious consideration of timing.
Their defense is factually correct, but misrepresents the lack of objectivity of their coverage. Rather than go through their defense point-by-point (something anticipated fairly well in the initial posting), I only request that they reread their coverage and ask themselves one question: Can Bloomberg do better? I believe so, or I would not be writing this.
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